Vertical Restraints and Vertical Aspects of Mergers--A U.S. Perspective

I. Introduction.

The history of the U.S. approach to vertical nonprice antitrust issues can safely be called checkered. All three branches of our government have struggled over the years, not always consistently, to define the line between permissible and impermissible conduct in this area. These fluctuations in policy and law are not surprising since vertical issues are complicated, hold possibilities of both competitive harm and efficiencies, and lead reasonable people to differ in close cases.

To give one example of our vacillating views, the U.S. Supreme Court over a period of just 14 years in the 1960s and 1970s, ranged from an essentially agnostic approach to vertical customer and territorial restrictions, to creating a rule of per se illegality for most of these restraints, and finally to overruling itself and reverting to a rule of reason approach.(2) In a similar vein, the Justice Department provoked strong reactions in 1985 when it issued its Vertical Restraints Guidelines, which took a very generous view of the legality of all vertical restraints.(3) Congress and the National Association of Attorneys General denounced the Guidelines,(4) business did not heed them, and the Justice Department rarely enforced them. Only eight years after their adoption, the Department repudiated the Guidelines when then Assistant Attorney General Anne Bingaman withdrew them in one of her first public acts after taking office.(5)

Why have we struggled so long and hard in this area? In large part it is because, while consensus exists on how horizontal agreements can facilitate collusive pricing or behavior (and in the merger context cause anticompetitive harm by facilitating a unilateral change in behavior), some controversy remains over how vertical nonprice arrangements create anticompetitive effects. Vertical nonprice restraints can cause harm in two basic ways. First, they can facilitate collusion among competitors by helping competitors to overcome obstacles they otherwise would face in attempting to maintain prices above competitive levels. Second, they can raise competitors' costs. By foreclosing or disadvantaging competing firms, vertical restraints create barriers to entry or expansion, so that rivals can no longer discipline the offending firm's price increases. We accordingly analyze vertical restraints in two categories -- those that can lead to collusion and those that can lead to exclusion. Often the same restraint (or the same type of restraint) achieves anticompetitive effects through both collusion and exclusion.(6)

Antitrust treatment of vertical restraints is also complicated by the view, accepted by most economists and attorneys, that such restraints often have the purpose and effect of generating substantial efficiencies. As one example, distributors may be unwilling to invest in the marketing of new products or services unless the manufacturer imposes a territorial restraint that ensures that late-entering distributors will not "free ride" on the earlier distributors' initial efforts and investments to establish the manufacturer's position in the marketplace. Thus, the frequent presence of real efficiencies combined with an uncertainty about anticompetitive effects explains why antitrust treatment of vertical nonprice restraints has been somewhat erratic.

Interestingly, in the United States today, we think about vertical nonprice restraint cases and vertical mergers (or the vertical aspects of mergers) in much the same way. This is because the vertical practices or restraints at issue in non-merger cases pose the same possibilities of competitive harm and the same potential for efficiencies as do those vertical practices or relationships in merger cases.(7) The EC, in contrast, appears to distinguish its analysis of non-merger vertical restraints from its analysis of vertical mergers to a greater degree than the U.S. The EC's different approach to vertical mergers (or vertical aspects of mergers) is likely attributable to some extent to how it assesses efficiencies in the merger context.

Significantly, there is little difference in how our systems analyze efficiencies stemming from vertical restraints in the non-merger context. In a classic non-merger vertical restraint case, both the European Community's Article 85(3) and the U.S. rule of reason approach require a competitive analysis in which anticompetitive harms and procompetitive efficiencies are assessed and balanced. In the merger context, however, the U.S. enforcement agencies take efficiencies into account and will not challenge a merger if the verified efficiencies are of a magnitude and character such that the merger is unlikely to be anticompetitive in any relevant market.(8) Under the Community's Merger Control Regulation,(9) in contrast, there is no recognized efficiencies defense or Article 85(3)-type balancing. As the European Commission has explained it:

There is no real possibility of justifying an efficiency defense under the Merger Regulation. Efficiencies are assumed for all mergers up to the limit of dominance -- the "concentration privilege." Any efficiency issues are considered in the overall assessment to determine whether dominance has been created or strengthened and not to justify or mitigate that dominance in order to clear a concentration which would otherwise be prohibited.(10)

Frédéric Jenny has commented, "far from allowing an efficiency defense for mergers, the EC Commission has so far considered mergers which contribute to economic efficiency more likely to create a dominant position than other mergers."(11) This characterization of how the EC treats efficiency claims in mergers is reminiscent of the reasoning of some 1960s U.S. Supreme Court decisions that were considerably more hostile to merging firms' efficiencies claims than are U.S. courts today.(12)

While the Commission's discussion of efficiencies in de Havilland(13) left open the issue of whether they can be cited in defense of a merger, it is clear that efficiency claims face more opposition in EC merger enforcement than in the U.S.

II. Vertical Restraints.

A. Territorial Restraints.

Territorial restraints can both facilitate collusion or enable exclusion. For example, by placing territorial restraints on their distributors, two manufacturers could agree tacitly to stay out of each others' territories. Alternatively, a retailer that is well-established could use territorial restraints with a manufacturer to prevent competing retailers from gaining access to a key good and thereby make it costly for them to invade its territory.

Historically, the EC and the U.S. have brought different perspectives to the analysis of territorial restraints. As noted earlier, U.S. law today treats vertical territorial restraints under a generous rule of reason.(14) One reason courts can be open-minded is that U.S. antitrust law has never been freighted with the need to insure an integrated internal market. The U.S. Constitution had done the work of knitting the states and territories together long before the Sherman Act was passed in 1890.(15) Perhaps most important from a competition standpoint is the U.S. Constitution's Commerce Clause, which prohibits the states from burdening or discriminating against interstate commerce. No state can enact laws that favor its producers over out-of -state producers without clear justification. As a result, state boundaries with respect to most products and markets are of little significance to competition in the United States.(16)

In contrast, the Treaty of Rome requires the Community to create a "system ensuring that competition in the internal market is not distorted."(17) This has been construed in a manner that makes the Community's competition rules an important vehicle for achieving the Treaty's goals of fuller economic integration and a seamless internal market.(18) The presence of the market integration and prosperity goals that inform the EC's competition law -- and their notable absence from U.S. antitrust law -- largely explains why some territorial restraints that are not a problem from a U.S. perspective are quite suspect in the Community. For example, assume that a well-established manufacturer relied on exclusive dealing and territorial restraints that were based on U.S. state or EU Member State lines to better promote its products or to prevent other manufacturers from invading its markets. The fact that the manufacturer assigned territories that correspond to state boundaries would be largely irrelevant to U.S. authorities; what would matter is whether market power existed and whether exclusion or foreclosure was possible. I suspect, however, that DGIV would seriously question those territorial restraints if they were based on Member State boundaries, particularly if they prohibited parallel imports. As the European Commission stated in its 1996 Green Paper on Vertical Restraints:

[G]iven the market integration objective [of the EC Treaty], any system of absolute territorial protection will normally be judged contrary to what is a fundamental objective of the Treaty, and will consequently be held incompatible with the competition rules.(19)

B. Exclusive Dealing Arrangements.

I turn next to another form of vertical restraint--exclusive dealing contracts.

U.S. Law. Even early American case law recognized the efficiencies of such arrangements, in which a buyer agrees to buy a product exclusively from one supplier for a given period of time. In an often quoted passage from Standard Stations, a 1949 Supreme Court case, Justice Frankfurter stated for the Court that exclusive dealing contracts may well be of economic advantage to buyers as well as sellers, and thus indirectly of advantage to the consuming public. In the case of the buyer, they may assure supply, afford protection against rises in price, enable long-term planning on the basis of known costs, and obviate the expense and risk of storage in the quantity necessary for a commodity having a fluctuating demand. From the seller's point of view, [the contracts] may make possible the substantial reduction of selling expenses, give protection against price fluctuations, and . . . offer the possibility of a predictable market.(20)

In addition to establishing price certainty and lowering transaction costs, exclusive dealing contracts can also prevent free-rider problems in a situation where, for example, a manufacturer invests in certain retail equipment for its product and seeks to ensure that the retailer only sells its brand of that product.(21)

But exclusive dealing contracts can also compromise a competitive market, in the two ways -- exclusion or collusion -- that I mentioned earlier. First, as with vertical mergers, exclusive dealing arrangements may erect entry barriers by foreclosing segments of markets from competitors. As the First Circuit stated in U.S. Healthcare, Inc. v. Healthsource, Inc.:

An exclusivity arrangement may "foreclose" so much of the available supply or outlet capacity that existing competitors or new entrants may be limited or excluded and, under certain circumstances, this may reinforce market power and raise prices for consumers.(22)

Moreover, where exclusive buying arrangements are widespread in an industry, they can reduce competition by facilitating cartelization by sellers.(23) Even in a market where sellers are prone to coordinate, buyers may be able nonetheless to force them to bid against one another. But this leverage is lost if the buyers' transactions are confined by exclusive dealing contracts.

Early American cases, while recognizing the potential efficiencies of exclusive dealing arrangements, nevertheless took a hard line against them. In Standard Stations, the Court appeared to suggest that exclusive arrangements were close to per se illegal if a substantial dollar volume of commerce was covered by the contracts, even when the particular contracts at issue foreclosed only a small percentage of a given market. In that case the seller's contracts covered only 6.7% of all gasoline sales to retailers, though there was a pattern of exclusive contracts, covering many sales in the industry, that concerned the Court.(24)

Courts today use a rule of reason approach to evaluate exclusive dealing contracts. In Tampa Electric,(25) decided twelve years afterStandard Stations, the Court outlined the analysis that lower courts have looked to since. The Court first defined the product and geographic markets and then sought to determine whether the contract at issue foreclosed competition in a "substantial share of the relevant market."(26) The Court explained that "opportunities for other traders to enter into or remain in that market must be significantly limited" before the contracts would be declared invalid.(27) Factors the Court thought relevant to the determination of "substantiality" were: the strength of the parties, the percentage of commerce involved, and the present and future effects of foreclosure on effective competition in the market. Finally, the Court seemed implicitly to measure these effects against the efficiencies that exclusive contracts generate.(28)

Recent lower court cases,(29) and Justice O'Connor's concurrence in a 1984 Supreme Court case, Jefferson Parish,(30) suggest a safe harbor for exclusive dealing contracts that foreclose less than 20% of the market, and probably even 30%. In their rule of reason analysis, courts have examined the duration of contracts, entry barriers, possible efficiencies, and other factors to determine to what extent contracts foreclosed competition.(31)

In the 1980s, the federal enforcement agencies viewed all exclusive deals with a generous eye, and brought no cases. But exclusive dealing arrangements are no longer off the enforcement table, at least when large percentages of a market are at stake and their duration is substantial. Last year, for example, the FTC entered into consents with Hale Products, Inc. and Waterous Company, Inc. after an investigation into their exclusive dealing arrangements.(32) Both companies manufactured water pumps for fire engines, and they allocated their customers, fire engine manufacturers, between them through the use of exclusive dealing agreements. Together they accounted for 90% of the fire pump market in the United States, and it was clear that they each sold most, if not all, of their pumps through exclusive arrangements and had done so for fifty years.

The alleged anticompetitive effects of these arrangements were, first, to make it easier for the two companies to charge supracompetitive prices because each often acted much like a monopolist with respect to its own customers. The contracts thus facilitated de facto market division. Second, the contracts were alleged to create barriers to entry that would foreclose competitors because the business of the vast majority of potential fire-pump customers was unavailable to any new entrant. The consent orders in those cases prohibited all present and future exclusive dealing arrangements.(33)

Community law. European law is generally more suspicious of exclusive dealing contracts than modern American law, though Commission statements clearly reflect an appreciation of their efficiencies.(34) Exclusive purchasing contracts, as they are referred to in Community law, can be examined under either Article 85 or 86. In addition, block exemption 1984/83 exempts such contracts when the goods purchased are for resale, and when certain other requirements are met, including a contract duration of no more than five years.(35)

One strand of Community law under Article 86 has focused on whether the supplier is dominant in the market, and has abused that position by entering into exclusive purchasing arrangements. For example, the Court of Justice in Hoffmann/La Roche, an Article 86 case in which the court condemned the exclusive dealing arrangements at issue, stated that: "An undertaking which is in a dominant position on a market and ties purchasers . . . to obtain all or most of their requirements exclusively from the said undertaking abuses its dominant position . . . ."(36) Likewise in 1990, the Commission found invalid certain exclusive arrangements by Solvay et Cie SA, a producer of soda ash, a substance used in glass manufacturing, in part because the contracts "consolidat[ed] the dominant position of Solvay."(37)

In the Delitimis case,(38) the European Court of Justice adopted a foreclosure analysis under Article 85, holding that exclusive purchasing agreements do not restrict competition and thus fall under Article 85(1) unless they make a "significant contribution" to the foreclosure of competitors from the market.(39) It is not yet clear, as some commentators have pointed out, whether the Commission will follow the analysis set out in Delitimis.(40) In 1993, for example, the Commission found, without conducting an analysis of the effects of the contracts on market foreclosure, that Article 85(1) applied to two ice cream suppliers' exclusive contracts with retailers.(41)The contracts accounted for only 10% and 15% respectively of retail sales in the so-called "impulse" ice cream market, but nevertheless, a violation was found.(42) Other cases, however, reveal the Commission's primary concern with market foreclosure.(43)

Boeing. Given the somewhat different approaches to exclusives that the U.S. and EC have historically taken, it is perhaps not surprising that we viewed the issue of the exclusive contracts in the Boeing case differently. As you will recall, prior to consummating the merger, Boeing had entered into contracts with three major US-based airlines in which the airlines agreed to buy substantially all of their aircraft requirements exclusively from Boeing for twenty years. The exclusives accounted for about 11% of the commercial aircraft market--though the percentage would be higher if you looked at only that class of airlines, the so-called "launch customers," that can serve effectively as a first customer for a new airplane.

Without more, our courts likely would not have recognized the exclusives as an anticompetitive problem. While it is true that Boeing has an approximately 60% market share in commercial aircraft, U.S. courts have not typically analyzed exclusives by looking primarily at the market share of the seller. That is one factor, but only one of many, in determining how the exclusive dealing arrangements actually affect competition. In the Boeing case, the market foreclosure was not substantial in U.S. antitrust terms. As I noted, recent U.S. cases seem to have created a safeharbor for exclusive dealing arrangements that foreclose under 30% of the market, and certainly under 20%. The FTC's majority statement did note that the exclusives were "troubling" and that the FTC would monitor the effects of them and any future agreements.

Because Community law appears more willing to characterize exclusives as a way that a dominant firm may increase its influence, the EC may have looked at Boeing's exclusives differently.

While I am on the topic of Boeing, let me take this opportunity to say a few more words about that matter. First, I want to be clear that I fully support the excellent cooperative relationship we have established with DGIV. Our history of cooperation has led to many positive outcomes in specific cases and will be increasingly important in this world where commerce transcends national boundaries, and where anticompetitive conduct can affect people halfway around the world from where the conduct occurred. Antitrust authorities have the right to review transactions that have a direct effect on consumers within their jurisdiction, and because consumers from more than one jurisdiction are often affected by the same conduct, more than one competition authority will want to review a single transaction.

Cooperation and coordination can bring us together most of the time. And there have been many cases in which our cooperation with DGIV has lead to remedies that satisfy both authorities. But we will not agree on an approach or a remedy every time. Sometimes our laws will lead us on clear paths to different conclusions, even when we are examining the same global market. An example is the Ciba-Geigy/Sandoz matter in which the EC approved the merger without any demands regarding the global innovation market for gene therapy, but we required Ciba-Geigy to divest critical research and development assets. Different outcomes should not really surprise us, given that U.S. and EU law have each taken different approaches at different times. Indeed, even within a single legal system, decisions in any given case in either of our jurisdictions are not always unanimous. It may be expecting too much, therefore, that two different institutions applying two different bodies of law, perhaps even examining different facts, will always arrive at the same conclusions.

Others have noted, and I agree, that differences in our laws may have accounted for many of the differences in approach that we and the EC took in the Boeing case. My understanding is that a principal inquiry of European merger law, as in exclusives analysis, is whether a merger will strengthen a dominant firm. In the de Havilland decision,(44) for example, the European Commission challenged the combination of French, Italian and Canadian manufacturers of commuter aircraft whose market shares increased from 46 to 63%, and concluded that the higher market shares would give the combined firms advantages in pricing flexibility (for example, the ability to offer a joint price on a wider range of models) and the ability to offer a wider range of product models with similar technology (which could make switches to other suppliers without similar technology more expensive). Several of the Aanticompetitive effects@ identified by the EC in that case would not be given much weight in an American court; indeed, they might be regarded today as efficiencies rather than anticompetitive effects. In the United States, the emphasis is less on remaining competitors and the merged firm's Acompetitive leverage,@ and more on the effect of a merger on future prices and output levels in a given market. As a result, Douglas's future potential to compete was critical to our inquiry of whether the merged firm lessened competition. The merger would only have a future substantial effect on output and prices if Douglas, standing alone or in the hands of a different purchaser than Boeing, would likely be a viable competitor. Because we concluded that was not likely, it logically followed that the merger's effect on prices and output would not be appreciable. That approach to enforcement is rooted in many decisions, including General Dynamics, decided over 20 years ago.(45)

III. Vertical Aspects of Mergers.

A. U.S. Law.

Antitrust enforcement of vertical mergers has evolved much as enforcement of the law of vertical restraints. Prior to the late 1970s, the government challenged a number of vertical mergers, and would usually succeed even with relatively small levels of foreclosure.(46) In cases like Brown Shoe Co. v. United States(47) and Ford Motor Co. v. United States,(48) the courts looked critically even at small amounts of foreclosure and were generally unsympathetic to the efficiencies that could arise from vertical consolidations.

As with non-merger vertical restraints, the courts' analysis of vertical mergers began to change in the late 1970s. Some lower courts were less than sympathetic to vertical merger challenges, even when the market shares were relatively significant.(49) In 1982, the Justice Department revised its Merger Guidelines which significantly liberalized the treatment of vertical mergers.(50) Not surprisingly there were almost no challenges of vertical mergers during the 1980s.

More recently, the antitrust agencies have begun to look more critically at vertical mergers and joint ventures and have challenged several vertical mergers.(51) This is in part due to more careful economic analysis of the effects of vertical mergers, and vertical restraints generally.(52) In these cases, the agencies have not revived the simpler approaches of a generation ago that found violations solely because there was significant foreclosure in the market. Rather, we have focused on the actual impact of that foreclosure on competition.

A vertical merger involves firms that operate at different but complementary levels in the chain of production and/or distribution. The defining characteristic of a vertical merger is that the product or service produced by one firm can be used as an input to the product or service produced by the other firm. Common examples include a merger between a manufacturer and a distributor, or a merger between two manufacturers, one of which produces an end product and the other a component of that end product.

Because, by definition, the parties to a vertical merger do not operate in the same relevant market, the merger does not lessen actual competition between the two firms. However, both the courts and the Commission have recognized that competitive harm can result from vertical mergers in certain situations. The 1984 Merger Guidelines(53) -- which are the current guides for non-horizontal mergers -- describe several theories of possible competitive harm from a vertical merger. One common thread that runs through them is that the analysis looks to the merger's potential effects on horizontal competition at one or more of the levels of production or service at which one of the merging firms operate. Let me discuss in the merger context the two theories of the potential anticompetitive effects of vertical restraints that I suggested earlier: foreclosure and collusion.

One theory of competitive harm under the 1984 Merger Guidelines is that a vertical merger could require a would-be entrant to enter the upstream and downstream markets simultaneously in order to be successful. For example, in an industry with a high degree of vertical integration and a limited independent supply of product in the upstream market, an entrant into the downstream market may find it necessary to enter the upstream market as well. If such "two-level" entry is more risky, more difficult, or more time-consuming than entry into the entrant's primary market alone, a merger that increases vertical integration could create barriers to entry.

A vertical merger could also facilitate collusion. The 1984 Merger Guidelines posit two ways in which this could happen. First, vertical integration by an upstream firm into the retail level may facilitate collusion in the upstream market by making it easier to monitor downstream prices. The ability to monitor downstream prices may make it easier to determine whether upstream firms are cheating on a collusive scheme. Second, the acquisition of a particularly disruptive buyer in a downstream market may facilitate collusion in the upstream market by eliminating an incentive to cheat on a collusive scheme in order to gain the buyer's business. Before the merger, the disruptive buyer may have been playing one firm against another to obtain the best price. With the disruptive buyer no longer independent of the upstream firms, collusion may be easier to maintain.

B. Time Warner

To illustrate some of the issues that enforcement agencies must struggle with, let me review several aspects of the Federal Trade Commission's enforcement action requiring restructuring of the proposed deal involving Time Warner.(54)

The case involved three media giants: Time Warner, Turner, and TCI. The markets involved were cable television programming and cable television distribution. Time Warner indirectly owns HBO and Cinemax, two cable networks devoted to premium movies, and also is the second largest cable television distributor, serving approximately 11.5 million cable subscribers or approximately 17% of U.S. cable television households. Turner is a leading cable programmer, and owned several "marquee" cable networks:(55) Cable News Network (CNN), Turner Network Television, and TBS SuperStation. It competed primarily at the level of HBO and Cinemax. TCI is the nation's largest cable distributor, serving approximately 27% of all U.S. cable television households. Between them, Time Warner and TCI accounted for about 44% of all U.S. households with cable service. Finally, TCI was also a leading provider of cable programming.

In September 1995, Time Warner and Turner entered into an agreement for Time Warner to acquire the approximately 80% of the outstanding shares in Turner that it did not already own. TCI and its affiliates had an approximately 24% existing interest in Turner. By trading their interest in Turner for an interest in Time Warner, TCI would acquire approximately a 7.5% interest Time Warner, with the potential, under the terms of the agreement, to increase that interest to more than 17%.

Let me touch on three aspects of the case, that are relevant to today's discussion: (1) the potential foreclosure of rival programmers from access to Time Warner's distribution and foreclosure of rival cable systems from programming controlled by the merging parties; (2) the potential foreclosure of an alternative all news channel that might compete with CNN; and (3) concerns over TCI's ownership interest in Time Warner.

Programming Foreclosure. One of the most important aspects of the transaction was the degree to which it increased vertical integration in the cable television market. Prior to the acquisition, Time Warner and TCI, the two largest cable systems in the U.S., had some relatively significant cable programming holdings. But this acquisition dramatically increased those holdings, by putting several significant cable networks under Time Warner's control. Thus, the complaint alleged that post-acquisition, Time Warner and TCI would have the power to: (1) foreclose unaffiliated programming from their cable systems to protect their programming assets; and (2) disadvantage competing cable distribution systems, by denying programming, or providing programming only at discriminatory (i.e., disadvantageous) prices. For example, post-merger Time Warner would have had the incentive and ability to foreclose alternative cable networks from its distribution systems in order to give its own programming a competitive advantage. Although there was some disagreement about the effect of the increased vertical integration, a majority of the Commission determined that it would have a significant impact on Time Warner's incentives and barriers to entry in programming.

First, it is important to recognize the degree of vertical integration involved. Post-merger Time Warner alone would control more than 40% of the programming assets. Time Warner and TCI, the nation's two largest cable systems, would control access to about 44% of all cable subscribers. Under U.S. case law, these levels of concentration can be problematic.(56)

Second, there was reason to believe that this acquisition would increase the incentives to engage in this foreclosure without remedial action. For example, the launch of a new channel that could achieve marquee status would be much more difficult without distribution on either the Time Warner or TCI cable systems. Because of the economies of scale involved, the successful launch of any significant new channel usually requires distribution on cable systems that cover 40-60% of subscribers.

Thus, the Commission recognized that one effect of the merger might be to heighten the already formidable entry barriers into programming by further aligning the incentives of both Time Warner and TCI to deprive entrants of sufficient distribution outlets to achieve the necessary economies of scale. The order imposed three provisions to address the impact of the acquisition on entry barriers. First, the order prohibits Time Warner from bundling the most desirable "marquee" channels with less desirable programming to compel local cable systems to accept unwanted channels and further limit available channel capacity to non-Time Warner programmers. Second, the order contains conduct and reporting requirements to provide a mechanism for the Commission to learn of situations where Time Warner might discriminate in handling carriage requests from programming rivals. Finally, the order reduces entry barriers by eliminating the programming service agreements (PSAs), which would have required TCI to carry certain Turner networks until 2015, at a price set at the lower of 85% of the industry average price or the lowest price given to any other program distributor. The PSAs would have reduced the ability and incentives of TCI to handle programming from Time Warner's rivals. Channel space on cable systems is scarce. If the PSAs effectively locked up significant channel space on TCI, the ability of rival programmers to enter would have been harmed. This effect would have been exacerbated by the twenty-year duration of the agreement and the fact that TCI would have received a substantial discount over prices given to other program distributors. Eliminating the twenty-year PSAs and restricting the duration of future contracts between TCI and Time Warner restored TCI's opportunities and incentives to evaluate and carry non-Time Warner programming.

All News Network. Of the types of programming in which the post-merger Time Warner would have a leading position, the one with the fewest existing close substitutes was the all-news segment, in which CNN was by far the most significant player. There were actual or potential entrants that could in the future erode CNN's market power, but their ability to do so would be partly dependent on their ability to secure widespread distribution. New entry might not have been successful because Time Warner's acquisition of CNN gave it both the ability and incentive to deny competing news services access to its extensive distribution system. To remedy this potential anticompetitive effect, Time Warner was required to place a news channel on certain of its cable systems; choice of the channel and the terms of the arrangement were left to negotiations between the parties. Time Warner satisfied these conditions by providing access to MSNBC.

TCI Ownership Interest. The question of TCI's partial stock ownership interest in Time Warner presented an exceptionally controversial issue for review. Although the initial interest acquired was about 7%, TCI had the ability to increase that interest to 17% without further antitrust review. Some might suggest that such an ownership interest was unlikely to raise any competitive problems.

The majority of the Commission did not agree. Such a substantial ownership interest, especially in a highly concentrated market with substantial vertically interdependent relationships and high entry barriers was thought to pose significant competitive concerns.(57) In particular, the interest would give TCI greater incentives to disadvantage programmer competitors of Time Warner because it would benefit financially by carrying Time Warner programs. Similarly, the stock investment could influence Time Warner's decision whether to carry programming that competed with TCI. The Commission's remedy was to eliminate these incentives to act anticompetitively by making TCI's interest truly passive.(58)

IV. Conclusion.

Though the treatment of vertical restraints and mergers in the United States historically has not been clear and consistent, I think we have now arrived at a sensible approach. We no longer condemn vertical arrangements without regard to their efficiencies. Neither, however, do we allow theoretical economic efficiencies to blind us to the possible anticompetitive effects of a vertical restraint or merger. We look to what the actual effect in the marketplace is or will be, and thus try to cull out only the harmful transactions while leaving the vast majority of efficient arrangements intact.

Some arguments posed by the critics of our action in Time Warner, to the effect that enforcement efforts were unnecessarily and unduly aggressive, echo the theories and approaches applied to merger analysis in the mid-1980s. In that period of minimalist merger enforcement, barriers to entry were almost always seen as low, tie-in sales and bundling were thought to achieve efficiencies, foreclosure as a result of vertical integration was thought to rarely harm consumers, and it was appropriate to presume efficiencies as a result of transactions (on the theory that otherwise the transaction would not have occurred at all). On the other hand, those who suggested greater enforcement may have been tempted to return to the "structural approach" of the 1960s, relying primarily on a market share foreclosure and ignoring issues like barriers to entry or efficiencies. Yet neither of these approaches is adequate to face the challenge of analyzing the evolving competitive alliances that will increasingly become part of the U.S. economy.

The types of competitive alliances of the 1990s are not the same as the 1980s, or the 1960s. Firms are increasingly turning to complex vertical arrangements to create strategic alliances. Alliances may be structured with direct competitors holding financial interests of one another. The promise of new technologies offers the opportunity for the expansion of competition, but incumbents may hold the keys to vital gateways for these new entrants. I think our current approach to vertical arrangements is a sensible response to these new realities.

Endnotes:

1. Chairman of the Federal Trade Commission. The views expressed herein are those of the Chairman and not necessarily those of the Commission, any other Commissioner, or FTC staff.

2. See White Motor Co. v. United States, 372 U.S. 253 (1963) (remanding for a determination of the competitive effects of exclusive territorial and customer restrictions); United States v. Arnold, Schwinn & Co., 388 U.S. 365 (1967) (holding territorial restraints to be per se unlawful); Continental T.V., Inc. v. GTE Sylvania, Inc., 433 U.S. 36 (1977) (holding vertical nonprice restraints to be judged under the rule of reason).

6. See, e.g., RxCare of Tennessee, Docket No. 951-0059 (Jan. 19, 1996) (MFN clause used by a pharmacy service administrative organization, which included at least 95% of all pharmacies in Tennessee and offered itself as a pharmacy network to third-party payers, facilitated collusion and produced a uniform price floor, since any participating pharmacy's discount to a competing plan had to be extended to RxCare itself, which accounted for 50% of the sales volume in the likely relevant market); United States v. Delta Dental Plan of Arizona, Inc., 59 Fed. Reg. 47,349 (D. Ariz., filed Aug. 30, 1994) (challenging on both collusion and exclusion theories an MFN clause in Delta Dental's agreements with participating dentists that led dentists to refuse to discount their fees to patients who did not have Delta Dental coverage, since clause required the dentists to offer the same discounts for Delta's patients, and Delta had contracts with approximately 85% of dentists in Arizona).

7. Moreover, some so-called vertical cases are not truly vertical, but rather are cases involving horizontal combinations among dealers to affect conduct by actors in some vertically related market. Likewise, some mergers may occur between what are predominantly horizontal competitors, yet a complementary aspect of their two businesses may allow them to exchange anticompetitive information and collude with rivals or exclude rivals by disadvantaging them. (See, e.g., Lockheed/Martin-Marietta, Docket no. C-3576, Decision and Order (May 9, 1995), which involved a merger between two essentially horizontal competitors, whose products occasionally were in vertical relationships, such as satellites and launchers or planes and radar devices). The search for horizontal purpose and effect is a constant theme in the analysis of vertical restraints.

10. Contribution from the Commission of the European Union to the Committee on Competition Law and Policy of the Organization for Economic Co-operation and Development (OECD) concerning Efficiency Claims in Mergers and Other Horizontal Cooperative Agreements (Nov. 1995) (available on OECD Homepage of World Wide Web).

12. See, e.g., FTC v. Procter & Gamble Co., 368 U.S. 568, 580 (1967) (noting that "possible economies cannot be used as a defense to illegality. Congress was aware that some mergers which lessen competition may also result in economies but it struck the balance in favor of protecting competition."). In fact, in Brown Shoe, the Supreme Court found that the existence of efficiencies cut against the legality of the merger. Brown Shoe v. United States, 370 U.S. 294, 344 (1962).

16. One could view the Commerce Clause as the equivalent of a federal trade law that early on removed state tariff and non-tariff barriers and lessened the likelihood that private anticompetitive restraints would replace governmental barriers.

17. Treaty establishing the European Community, Article 3(g) (Treaty of Rome, 25 March 1957), as amended, reprinted in European Union, Selected Instruments Taken from the Treaties, Book I, Vol. 1 (Luxembourg: Office for Official Publications of the European Communities, 1993).

18. See, e.g., Consten and Grundig v. Commission, 1966 ECR 299, 341 (noting that "what is particularly important is whether the [alleged anticompetitive] agreement is capable of constituting a threat, either direct or indirect, actual or potential, to freedom of trade between member states in a manner which might harm the attainment of the objectives of a single market between states").

31. See, e.g., Ferguson v. Greater Pocatello Chamber of Commerce, 848 F.2d 976, 982 (9th Cir. 1988) (finding that a six year lease for a campus stadium did not restrain competition); Thompson Everett, Inc. v. National Cable Advertising, L.P., 57 F.3d 1317, 1326 (4th Cir. 1995) (granting defendant's motion for summary judgment and noting that the common but short-term exclusive contracts generated efficiencies); U.S. Healthcare, 986 F.2d at 596 (finding that even when 25% of doctors are tied exclusively to one HMO, other HMOs are not foreclosed from entering).

32. Note that at one time, the analysis of exclusive dealing contracts under § 5 of the FTC Act was different from that under the Clayton Act § 3 line of cases. With the decision in Beltone Electronics Corp., 100 F.T.C 28 (1982), however, the FTC aligned its analysis withTampa Electric's rule of reason approach. See Antitrust Law Developments, supra note 29, at 220-21.

41. See Schöller Lebensmittel GmbH, O.J. L 183/1 (1993)(Comm'n); Langnese-Iglo GmbH, O.J. L 183/19 (1993) (Comm'n). The Commission did weigh the efficiencies of the arrangements against their competitive harms and analyzed their competitive effects. The Commission found that the agreements were anticompetitive.

42. The Commission defined the relevant market as prepackaged ice cream that is sold individually by retailers. See Schöller ¶ 87.

43. For a discussion of these cases see Barry E. Hawk, United States, Common Market, and International Antitrust: A Comparative Guide 490-92 (Supp. 1994).

58. Holdings of a minority interest are treated somewhat differently under U.S. and EU law. Section 7 of the Clayton Act covers acquisitions of minority interests, whereas the EC Merger Control Regulation applies to the acquisition of a minority interest only when that acquisition results in the "possibility of exercising decisive influence," i.e., control, on the acquired firm. Thus, in the case of Lockheed's 1996 acquisition of Loral, the FTC was able to examine Lockheed's retention of a 20% stake in Loral Space (which was spun off from Loral as part of the overall Lockheed/Loral transaction), whereas the EC found that the creation of Lockheed's 20% link to Loral Space would not confer upon Lockheed the possibility of exercising decisive influence on Loral Space, and did not examine it under the Merger Control Regulation. (The EC decision stated, however, that the link might infringe the competition rules of the EC Treaty and reserved its position on that question.) See Lockheed Martin Corporation/Loral Corporation, Case No. IV/M.697, European Commission Decision of 27 March 1996. However, in a case like Time Warner/Turner, where a significant minority share holding already exists (like TCI's in Time Warner), it appears that the EC could examine such a link as part of its competitive assessment of the case in main. See, e.g., Elf/Ertoil, Case No. IV/M.063, European Commission Decision of 29 April 1991, cited in van de Walle de Ghelcke & Van Gerven, Competition Law of the European Community § 8.04[3][d][I] (1996 supp.).

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